Portfolio expected return and risk Aa Aa A collection of financial assets and se
ID: 2821505 • Letter: P
Question
Portfolio expected return and risk Aa Aa A collection of financial assets and securities is referred to as a portfolio. Most individuals and institutions invest i portfolio, making portfolio risk analysis an integral part of the field of finance. Just like stand-alone assets and securities, portfolios are also exposed to risk. Portfolio risk refers to the possibility that an investment portfolio wil not generate the investor's expected rate of return. Analyzing portfolio risk and return involves the understanding of expected returns from a portfolio. Consider the following case: Andre is an amateur investor who holds a small portfolio consisting of only four stocks. The stock holdings in his portfolio are shown in the following table: Percentage of Expected Standard Deviation 32.00% 36.00% 39.00% 41.00% Stock Artemis Inc. Babish & Co Comell Industries Danforth Motors Portfolio 20% 30% 35% 1590 Return 8.00% 14.00% 12.00% 3.00% What is the expected return an Andre's stock portfolio? 15.68% 10.45%,Explanation / Answer
Expected return is probability weighted rate of return for individual constituents of portfolio.
For Andre portfolio, expected return is:
E(R) = (20% *8%) + (30% * 14%) + (35% * 12%) + (15% * 3%) = 1.6% + 4.2% + 4.2% + 0.45% = 10.45%
If the coefficient correlation between any two or more assets is less than 1, then according to portfolio theory, standard deviation of that portfolio would be less than the weighted average of constituents.
Hence, for the question given, standard deviation of portfolio would be LESS THAN 37%.